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You can contact the author (Teguh Hidayat) by email, teguh.idx@gmail.com. The author live in Jakarta, Indonesia.

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The Outlook of Coal Stocks: Update

Two
months ago, more precisely in the first week of October, I noticed the price of
coal, in
this case the benchmark
coal price of Newcastle Australia, which previously was falling down to
US$ 53 each ton in the beginning of 2016, it began to rerise to US$ 72. After I
had considered some analytical reasons, I inferred the rise might continue in
the long term, and as a result I chose one among the coal stocks that according
to me was a
great
stock, it was Harum Energy (HRUM),
its price was 1,050 (you may reread the analysis here).

Later, it was true that the
coal price continued to climb up, but no one would expect if its increase was
fast, that
today the coal price of Newcastle has hit the psychological level of US$ 100
by a ton! The results were predictable: Since early October, the coal stocks
skyrocketed to hundreds of percent in a matter of weeks, even though they had
risen much
before (the coal stocks had already increased since the beginning of
2016, but the transaction volume only significant enough after October). As an
illustration it’s HRUM, its highest price was 2,640, then it has increased to
300% YTD, but HRUM was not the only one, because most coal stocks have climbed
to hundreds of percent since the beginning of the year. When JCI has reached its peak in October as
the euphoria of tax amnesty reduced,
but the market was not lethargic as the investors had a new toy: The commodity
stocks, mainly coal.

But as
usual, when a certain stock or sector had an increase then some investors might
have bought the stock at a low price earlier, but other investors might buy the
stock at a high price, the problem was we could not expect a stock to keep
climbing up every day, but there must be
a downturn. And it happened to the coal stocks, in the latest two weeks
some coal stocks, although it’s not all, have started to fall. If you have
bought the stocks since the October, or earlier, you would have secured your
place. But what if you bought the stocks late? So, if that was the case then we have to review
the outlook for coal sector again and here we go!

First,
the price of Newcastle coal reaches the US$ 100 a ton, it is higher than the
coal company has ever predicted. What I remember was, in April 2016, United
Tractors (UNTR)’s management said the coal price at US$ 50’s each ton was low,
and for the next five years (it started from 2016) the coal price would rise to
around US$ 52 – 72 each ton. The
report from the management of HRUM also predicted the same thing, the coal
price in the future would be stable around US$ 75 each ton. And the latest one,
when the management of Bumi
Resources (BUMI) made a deal to end its liability issue with the
creditors, one of the assumption points used was the coal price, although it
might rise and fall in the short term, but it would not go down lower than US$
70 each ton.

But none
of three companies mentioned above said if the coal price would be stable at level US$ 100 by ton. But if
the coal price had risen or fallen to any position, including reaching US$ 100
each ton as for now, then it would have been adjusted and become stable at US$
70 – 75 each ton, or at least it was the prediction from the company. But it
might be different: When the management said if the coal price would be stable
at US$ 70 – 75 each ton, it was not a prediction, but the lowest assumption they expected to occur, if the price of coal
were low as in the past time, the production volume would be cut to reduce the
coal supply on the market (and indeed that was what UNTR and the rest had done
in 2015 – 2016). But if the coal price had risen to US$ 70 by ton, the higher
the better, the production volume would have been increased again.

However,
it doesn’t mean the coal price would keep rising, and the problem is the recent
condition is different with the ones in 2011, it skyrocketed to US$ 142 each
ton because of increasing demand from China which had high economic growth, but
for now it has started to (and still) slow down. When the coal price was rising
quickly, near two times in months, the possible reason was the technical
rebound after it had long downtrend for five years (since 2011), the rebound
showed the long-term downtrend had ended, but to rise to what it was in 2011
then it needs time, it may not take to five years, but it is not as fast two
last months.

Then
except if it has positive sentiment coming either from China, Japan, or
domestic, I think that sooner or later the coal price will fall for a while,
but it won’t drop below US$ 50’s, but US$ 70 is maximized. Then it may climb up
slowly but in a certain pace, but it will not as fast as it moved two months
ago, but it may become stable/stagnant on a certain level. When the price is
‘confirmed’ to go above US$ 70 by ton onwards, then BUMI and the others will
increase their coal production volume so it will increase the coal supply on
the market, and eventually it will make the coal price stuck on a certain
level.

Second,
if it’s true that
the coal price will fall in the future, the overheated stocks will also drop. Why do I say
overheated? Because some of the coal stocks were cheap, let’s say if its PBV is
1 time or less, but recently they are already more expensive than some blue chips.

As the
coal price is unlikely to fall below US$ 50’s per ton, HRUM and others will not
fall into their bottom positions in early 2016. The cooling down phase will
occur until April 2017, when the companies publish their financial statements
of Quarter I 2017, if the results are great then the coal stocks have the
fundamental reason to go up once again.

Not an euphoria
yet

Last,
third, the main question is, what is the fair valuation of the coal stocks? We
need to review their records in 2011, when the sector was at its greatest
period: In 2011, I remembered, the lowest PBV of a coal stock was about 4 times. The
coal stocks were regarded very expensive, they were more costly than the
consumer goods stocks, because the investors valued equity based on the proven
reserves owned by the enterprises. If PT A had equity of Rp1 trillion but its
market capitalization was only Rp5 trillion (PBV 5 times), but it was still
valued as cheap, because PT A had coal reserves at a trillion tons which if it
had dug the reserves and sold all the coals, then it would have got profit at
tens of trillions! Then once again if PT A had a market capitalization which
was five times bigger than its equity, it was still cheap, because the equity
did not count the ‘equity’ in the form of coal that had been proven underground,
but it had not been turned into money. Some companies were considered to have
huge coal reserves (compared with their annual production volume), their stocks
were valued at PBV 7, 9, to 11 times.

(but indeed, the most basic mistake
the analysts recommended about coal stock was they thought the current selling
price, it was US$ 140’s each ton, would be stable at that level and would never
fall)

Okay, it
was in 2011. But how do they perform now? Well, although the coal stocks
skyrocketed, the highest PBV only reaches three times (the share of PTBA), but it is already higher
than the most stocks’ valuations at IDX, which become cheap recently as IHSG
gets sluggish. And if you compare coal companies performances up to Quarter III
2016, where their incomes and net profits have not improved and their ROE’s are
low, it is obvious the current value of coal stocks is not cheap anymore. If the
coal price starts to consolidate, the coal stocks will drop for a while to find
their balance spots.

But when
the consolidation/cooling down phase ends, the coal stocks will rise again, and
this time their risings will be based on
the results of their financial statement’s performances at the beginning of
2017 (they will not go up together anymore because of the increased coal
price). As an illustration, I possessed two coal stocks in 2011 which
skyrocketed: Resource Alam Indonesia
(KKGI), it rose from 1,700’s to 8,000’s, and Garda Tujuh Buana (GTBO), from 100’s to 1,500’s and it was still
rising to 5,000’s in 2012 (sadly, I had sold GTBO far before it
rose to 5,000).

And.. did
you know why those two could skyrocket? Well, it was simple, because those two
stocks reported annualized ROE to 60
percent! Or it’s far higher than most of the coal stocks. Plus, when the big coal stockssuch as
BUMI and Adaro Energy (ADRO) had been valued at PBV 4 times, the PBVs of KKGI and
GTBO, based on their unincreasing prices (KKGI was at 1,000’s, meanwhile GTBO was at
100’s), were only less than two times, which probably because they were labelled
as small stocks
so that people
rarely paid attention to them, and noticed them only after they had extraordinary financial
reports.

If you
think the increase of coal stocks in recent months were great, then you has never had GTBO

So, trust
me, it does not matter if a stock rises a lot or the opposite happens that it
drops a lot in a short period, but finally people will look at their
financial statements, and its stock valuation.
Then our task is simple: On April 2017, focus yourself on analyzing financial
statements of all coal enterprises, find the one which has the best
performance, and the cheapest stock! Then buy it for mid or long-term.

Then what
should I do if I have already had a coal stock? Well, it does not matter if you
bought it earlier then you may gain profit, or you got it late then you are
stuck, but if you have a vision of the future, at least in April 2017, then
there is no reason for you to sell it in a hurry. Because even if the coal
price drops, but not go below US$ 70 a ton then the coal companies will still
increase their volume production, and it means their incomes with net profits,
and profitabilities will be ‘huge’ again, though not as huge as they
were in 2011, but ROE projection at 20 – 25% in 2017 for a healthy coal company
is sensible, and it will be a good reason to value the stock at PBV 2 – 3
times, or even higher.

Then,
last, you have to remember in 2011, everybody valued coal stocks based on the
reserves owned by the companies. But for now, as far as I know
there was no single analyst who mentioned ‘the coal reserves’, in which it
meant the coal sector had not reached its euphoria peak. If you want the most
recent illustration, in the early to mid 2013, the construction stocks
skyrocketed to a point which the analysts said that PBV 4 – 5 for Adhi Karya
(ADHI) was fair, considering the business had a long-term construction agreement at trillions Rupiah that had
not reflected on its equity (ADHI was at level 4,000. Let us see in what
position ADHI now?). Construction agreement we discussed here was
similar with coal reserves.

The
conclusion is, when people become unrealistic when they estimate a stock or sectoral valuation,
that’s
when the euphoria occurs, and the
stocks may fall
later. But the euphoria has not hit the coal sector so far, as the
valuation of the coal sector is not that high yet. And that means, with an
assumption that you still have the chance to hold the coal stocks for at least mid
period (from 3 to 12 months onwards, or longer), then the
opportunity is still there!

Original article was written (in Indonesian
Language) in November 28, 2016. For
inquiries, please contact the author by email teguh.idx@gmail.com